Sometimes, I think that monkeys could make better mutual fund managers! I was reading The Intelligent Investor, a book written by Benjamin Graham (please don’t tell me you don’t know him!) and he was explaining how our brain works completely against the way our investment portfolio should be managed.

I thought I would share this interesting theory with my fellow investors 😉

We have a tendency of creating trends

Human brains are one of the most powerful machines it has ever existed. However, powerful doesn’t mean useful in some situation! For example, when an event happens twice or three times in a row, our brain will automatically search to create a trend. It will release dopamine which makes you euphoric. Then, you will believe that you can predict what is going to happen next time the event occurs.

This is totally applicable to the stock market; if you buy a stock that rise two or three times in a span of 3 months, you will automatically be tempted to think it will continue its ascension as there is a “strong” historical trend.

As the stock goes up and down, your brain will create more dopamine so your can be kept in your “bubble”. When you see your investments taking a big hit, your heart will accelerate and the panic will become your new best friend.

Internet has greatly contributed to make you loose money

Based on this premise, the fact that you have now instant and live access to any quotes on the market is catastrophic for your investment strategy. How many times to you look at the stock market in a day? Do you feel bad when you can’t access to your stock quotes for a few hours?

Even thought I am trying to not trade on emotions, I still look-up my stocks 2 to 3 times a day. It is usually once in the morning, once at lunch time and at night, once the markets are closed. Is it useful? Absolutely not! In fact, it just adds more pressure to make trades… irrational trades 😉

Mr. Graham made a great example with properties. Have you ever call a real estate agent in the morning to know what is the value of your house? And then, call him the next day to make sure it hasn’t change? Would you ever consider selling your house if it losses 3% in six months?

You should have bought your house for a long term need and should not worry too much about its value in the meantime. This should also be applicable to your investment portfolio.

Comments

Kind of an odd title since humans are the ONLY (financial) traders in the world…

We’re certainly not well-adapted to trading in large-scale markets, but that very trait in turn influences the markets and CREATES movement and trends. Individually, our aversion to and rationalization of losses can be negative individually to those who can’t or simply don’t care to take control of their emotions. However, as a whole, our emotional reactions are simply part of the human market.

If you assume that markets rationally and efficiently value stocks, of course it will look like human emotions are bad. However, it is those same individuals who don’t understand emotions, trade based on emotions and discount psychology in markets that make the mistakes you’ve mentioned. In short, it’s not humans that are bad traders, it’s humans that ignore humanity that make poor trades.

Rich- Yes, this is correct. As you may know, Graham pioneered the value-oriented approach to stock investing and Buffet operates under this approach. It’s about finding solid companies with strong earnings prospects that have wrongly fallen out of favor. Essentially, these value investors are looking to take advantage of the market psychology described above.